TOL - 11th Sep, 2024
Prepare your portfolio for the next volatility spike and beyond
Get your portfolio in shape for the next drawdown, whenever it may be, in this latest episode of The Pitch.
Note: This video was taped on Thursday 22 August 2024.
The early August spike in volatility across global assets could still have long-lasting implications. For now, however, it seems it is all quiet on the market front, given investors could not immediately answer what the source of that spike was. It has been, in the grand scheme of things, a "head-fake" that created a fantastic, albeit lightning-fast, dip-buying opportunity for nimble investors.
But what if it wasn't nothing? It's never wise to fear-monger, but it is wise to prepare for aftershocks and, if you believe the bears, an even bigger earthquake to come.
That is where multi-strategy investing may come in handy. This alternative asset class aims to capture as much upside as possible while introducing as little extra risk as possible. It does this by employing a range of strategies, from capitalising on mispriced bonds to long-short equity strategies and finding relative value in the derivatives market.
It also happens to be an area in which Janus Henderson has deep expertise and experience - led by veteran derivatives trader and Head of Diversified Alternatives David Elms.
In Elms' last episode of The Pitch, we discussed the value of alternative investing in a benign environment. In this episode, we'll discuss how alternative investing can help prepare your portfolio for a market crash. Plus, Elms and I have an in-depth discussion about one of these strategies, how it works, and why it's worth learning about no matter your investing level.
EDITED TRANSCRIPT
They say the price of long-term returns is volatility. But that's usually in the context of stocks. Can the same be said for multi-strategy investing?
Elms: Multi-strategy investing aims to diversify risks across multiple strategies, and in our case, we do that across our risk-taking strategies. So we have six strategies that take bottom-up risks in pockets of inefficiency across markets, but we try and also have the best of both worlds and make volatility go away.
Now, that's never possible. They say the only perfect hedge is in a Japanese garden. But we do our best to find ways of mitigating risk in the portfolio. We run a seventh top-down strategy called protection.
How do you tend to approach volatility spikes, like the one we saw in early August 2024?
Elms: It's an interesting question. I don't think there's ever been a volatility spike like the one we saw in early August. We're talking now before the end of August, so possibly something will emerge that validates why we had that spike. But the unusual thing about what happened in August, compared with the other two big spikes (the Global Financial Crisis of 2008 and COVID in March 2020), is that this one went up and came down much faster than the others.
It was a head fake in the market. We had the sell-off in Japanese markets on that Monday, August 5th. It happened at a quiet time when there was not much trading desk coverage for things like the VIX. It also happened at a time when many senior traders were off in the Hamptons as you do in the Northern Hemisphere summer. Thus, the market responded dramatically to news that was very Japan-specific.
The VIX market went up a lot and it hit crisis levels. Then, when people asked what it was we were panicking about, it fell equally fast and it was that fast fall that was unusual. It meant as somebody hedging you had to monetise your hedges, take profits on them quickly, or you faced regret risk later in the month.
How much can you prepare your portfolio for situations like this?
Elms: You think about scenarios. You war game scenarios and you say, if this happens, if the market goes up significantly for no good reason, we're going to keep some of our hedges. We may be wrong, but we're going to monetise others. But it's that planning so that when something happens. You're not sitting down and trying to invent the playbook. You're just saying, we've identified it as scenario two, we're going to play scenario two and we're going to behave in this way.
You can also never model things perfectly. You are always going to be surprised. You have to ad-lib, you have to respond, and you have to be nimble. But the more planning you can do, the better your chances are of delivering the right outcome for your investors.
What were you doing on August 5th?
Elms: You can't create the strategies when everybody is panicking that benefit the portfolio. You need to have them in place before. Some strategies will attempt to use price information to pivot and effectively reshape the portfolio dynamically.
Trend following is a great example of that. When prices fall a little bit, they often fall a lot. A trend strategy gets in front of that. But in an environment like we saw in early August, things are moving too fast for that. You have to have the strategies in place and you have to respond to the moves in the market and the implications of those for your strategies.
Can you give me a specific example of a strategy that you would employ in a situation like the early August volatility spike?
Elms: A nice example (and it appeals to me as a derivatives trader) is VIX call options. So the VIX index, the Global Fear Index, is an index of the pricing of options on the US stock market. And when it's high, the market is fearful. Options are expensive because options limit people's losses in a crisis.
But somebody had the bright idea of having options on the VIX index, so you can bet about the VIX index going higher or lower. And then, of course, you can just perform the same calculation on the VIX options and create something known as the VVIX, which is the second-order VIX.
Now, anybody who reads a lot about financial markets knows the VIX was cheap this year. You mentioned it earlier in your introduction. The VIX was cheap, but what was somewhat less known, was that the VVIX was cheap. So not only was the VIX low, but options to bet on the VIX going up were very cheap.
One of the things we did was spend a small amount of money every month on buying these high-payoff VIX call options. And that's something that worked for us, but we had to be quick monetising it. If you didn't monetise it, they went up and they went down again and you had to look back with regret on the profits you missed.
See alternatives in a different light
To perform differently from the market, you have to invest differently. You can find further information on the Janus Henderson Global Multi-Strategy Fund here, or via the Fund Profile below.
Managed Fund
Janus Henderson Global Multi-Strategy Fund
Alternative Assets
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Hans is one of Livewire's senior editors. He is the creator and moderator of Livewire's economics series "Signal or Noise". Since joining Livewire in April 2022, his interview record includes such names as Fidelity International Global CIO Andrew McCaffery, JPMorgan Asset Management Global CEO George Gatch, and Lazard Chief Market Strategist Ron Temple just to name a few. He has a double degree in economics and journalism.
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Hans is one of Livewire's senior editors. He is the creator and moderator of Livewire's economics series "Signal or Noise". Since joining Livewire in April 2022, his interview record includes such names as Fidelity International Global CIO Andrew...
Expertise
Hans is one of Livewire's senior editors. He is the creator and moderator of Livewire's economics series "Signal or Noise". Since joining Livewire in April 2022, his interview record includes such names as Fidelity International Global CIO Andrew...
Expertise
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